Why mortgage and business loan rates won’t go as high as people think

I am convinced that mortgage rates will not go as high as some people expect, at least not as quickly. I say this because the dynamic between inflation, Fed rate hikes, economic growth and bond markets should cause the yield curve to flatten and even invert over the medium term, keeping rates low mortgages.

It is obvious that inflation is there, but what is not so obvious is what to do. The problem with inflation today is that prices are usually pushed up by supply-side constraints for a variety of reasons. The Fed has started to raise rates in an effort to calm demand, but it appears that any increase in the Fed Funds Rate will have an outsized effect on economic growth. This momentum will keep Treasury rates low as there is a strong correlation between economic growth and Treasury yields.

Also, if you really disregard inflation, it becomes apparent that a lot of it is for essentials like food, energy, etc., things that aren’t so easily influenced by monetary policy. So once we start getting colder inflation in the food and energy X items, which could be quick, it may become more apparent that rate hikes can be more gradual.

The general idea here is that as short-term rates rise, they will dampen economic growth, which will dominate long-term rates, creating a flat and even inverted yield curve during a period when short-term rates term are somewhat equal to or higher than long-term rates.

The other part of the mortgage rate equation is credit spreads, which have unfortunately widened significantly in recent weeks. This happens when there is overwhelming uncertainty in the bond markets about the direction of the economy and rates. I think what we really need here is just a little time for institutions and bond investors to know where things are going and where spreads will start to come back.

So to recap;

1) Short-term rate hikes will dampen economic growth, putting downward pressure on long-term Treasury yields, even as the FED unloads its balance sheet.

2) The food and energy X inflation will start to get under control and we won’t need to move the FF rate as quickly as people thought.

3) credit spreads will come into play once the market has calmed down and some of the uncertainty is lifted.

On top of that, there’s always the wild card that a positive development in the world of supply-side constraint will appear and everything will change overnight, such as settling the war in Ukraine, China toppling the zero Covid policy, the United States removing tariffs, etc. Do not underestimate the positive developments, as these issues are being actively worked on and could develop rapidly, completely altering the environment in which we find ourselves.

This article was submitted by an external contributor and may not represent the views and opinions of Benzinga.

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